Lehman Brothers and Corporate Governance failure By Adnan Qatinah Mohammed Ghiath Agha
Jan 28, 2015
Lehman Brothers
and
Corporate Governance failure
By
Adnan Qatinah Mohammed Ghiath
Agha
Contents• Introduction.
• Brief history of Lehman Brothers.
• The Board Structure on Lehman Brother.
• Causes of Lehman Brothers failure.
o Corporate Governance Failure.
o Technical Causes of Lehman Brothers failure.
o Other Causes.
• Conclusion.
IntroductionOn September 15, 2008, Lehman Brothers Holdings Inc filed for bankruptcy. It filed for protection under Chapter 11 of the U.S. Bankruptcy Code with the United States Bankruptcy Court for the Southern District of New York. It filed with $639 billion in assets and $619 billion in debt, Lehman's bankruptcy filing was the largest in history, as its assets far surpassed those of previous bankrupt giants such as WorldCom and Enron. Lehman was the fourth-largest U.S. investment bank at the time of its collapse, with 25,000 employees worldwide.
In this presentation we will focus in the corporate governance failure.
http://www.investopedia.com/articles/economics/09/lehman-brothers-collapse.asp#ixzz1fMgLOtOn
Brief history of Lehman Brothers
Henry Lehman, an immigrant from Germany, opens a small dry goods store in Montgomery, Alabama, in 1844. 1844
Henry is joined by brothers Emanuel and Mayer and they name the business Lehman Brothers. 1850
The Lehmans -- who take cotton from farmers to settle accounts and trade the cotton for money and merchandise -- open a New York office.` 1858
After the Civil War, they move to New York and establish the New York Cotton Exchange. 1860s
Become members of the New York Stock Exchange 1887
Lehman underwrites its first public offering, for the International Steam Pump Company. 1889
The Lehman Corporation is created, a closed-end investment company. 1929
Source: http://www.reuters.com/article/2008/09/13/us-lehman-factbox-idUSHAR27520620080913
Brief history of Lehman Brothers
Lehman underwrites the IPO of DuMont, the first television manufacturer. 1930s
Underwrites the IPOs of Digital Equipment and Hertz Rent-a-Car 1950s
Opens a Paris office. 1960
With Salomon Brothers, Merrill Lynch and Blyth and Company, Lehman forms an association nicknamed the "fearsome foursome" that challenges the major firms for underwriting business. 1962
Becomes one of the first investment banks to open an office in London to take advantage of the booming bond market in Europe. 1972
Lehman acquires Abraham & Co. 1975
American Express acquires Lehman Brothers and merges it with Shearson. 1984
Seat on the London Stock Exchange 1986
Source: http://www.reuters.com/article/2008/09/13/us-lehman-factbox-idUSHAR27520620080913
Brief history of Lehman Brothers
Seat on the Tokyo Stock Exchange 1988
American Express divests Shearson, and the independent firm once again becomes known as Lehman Brothers. 1993
Lehman becomes independent through a public stock offering and Lehman Brothers Holding Inc common stock begins trading on the New York & Pacific stock exchanges. 1994
Richard Fuld Jr takes the top job at Lehman. 1994
Fuld fights off rumors that the near collapse of Long Term Capital Management had caused a cash crunch at Lehman. 1998
Lehman establishes an alliance with Bank of Tokyo-Mitsubishi for Japanese mergers and acquisitions. 1999
Under pressure to cut costs, Fuld decides to pay staff less and in stock, rather than lay off employees. 2001
Source: http://www.reuters.com/article/2008/09/13/us-lehman-factbox-idUSHAR27520620080913
Brief history of Lehman Brothers
Lehman establishes its wealth and asset management division and acquires Lincoln Capital Management's fixed income business.
2002
Lehman acquires Neuberger Berman and The Crossroads Group. 2003
Lehman posts record-high net revenues, net income and earnings per common share (diluted) for a fourth consecutive year and the highest volume of trade on the London Stock Exchange for a third year in a row.
2007
On September15, 2008 Lehman Brothers Filed for Chapter 11 bankruptcy with about $613 billion in bank debt
2008
Source: http://www.reuters.com/article/2008/09/13/us-lehman-factbox-idUSHAR27520620080913
As glorious as this past may seem Lehman could not resist the subprime markets. In August of 2007 Lehman closed its subprime lender BNC Mortgage which left 1,200 positions gone. This clearly was only the beginning for Lehman and their mortgage and credit problems. In 2008 Lehman was posting unprecedented losses. For the most part their problems arose from holding onto lower grade tranches and holding on too long to subprime mortgages. It is up in the air whether they held onto to these assets because of a foolish investment move or whether their simply wasn’t a market for these assets. For the 2nd quarter the frim had $2.8 billion in losses and was forced to liquidate $6 billion in assets. It is simply stunning to see the stock movement for the firm:
9-Other inductors
The Board Structure on Lehman Brother
• Structural Attribute : Lehman Brothers
• Chairman : Richard S. Fuld, Jr
• CEO : Richard S. Fuld, Jr
• Number of board members : 10 members
• Number of current CEOs/Chairmen/President : 3
• Number of retired CEOs and years since their retirement : 3 retired, average 12 years
• Independent board members (according to NYSE) : 8 members
http://www.gsb.stanford.edu/cgrp/documents/CGRP03-LehmanBoard.pdf
www.afcar.net9
The Board Structure on Lehman Brother
Name Experience
ICHAEL L. AINSLIE Former CEO Sotheby’s
JOHN F. AKERS Former Chairman of International Business Machines Corporation
ROGER S. BERLIND Theatrical Producer
JOHNSON EVANS CEO American Red Cross
SIR CHRISTOPHER GENT Chairman GlaxoSmithKline
Vice Chairman RKO Pictures / Actress
THOMAS H. CRUIKSHANK Former CEO Halliburton
JOHN D. MACOMBER Principal JDM Financial
http://www.gsb.stanford.edu/cgrp/documents/CGRP03-LehmanBoard.pdf
Professional background of independent board members
www.afcar.net10
The Board Structure on Lehman Brother
Average age of board members : 68.4 years old
Committee meetings (2007-2008)• Audit Committee• Compensation and Benefits Committee• Nominating and Governance Committee• Finance & Risk Committee• Executive Committee
: 7: 8: 5: 2: 11
http://www.gsb.stanford.edu/cgrp/documents/CGRP03-LehmanBoard.pdf
11
The Board Structure on Lehman Brother
Numbers of Committees:
• Audit Committee
• Compensation and Benefits Committee
• Nominating and Corporate Governance Committee
• Finance and Risk Committee
• Executive Committee.
www.afcar.net12
The Board Structure on Lehman Brother
• The structure follow the one tier board structure (US model).
• Richard FULD hold the two positions CEO and Chairman of the
company.
• The board consists of high portion of independent directors eight
out of ten(whom met the independence standards of the New York
Stock on the board). In addition to five committees.
www.afcar.net13
The Board Structure on Lehman Brother
• The board met the structural standers and there is nothing unusual.
• Their average age was 68 versus 61 on the large company (a little high).
• Directors had a diversity professional experience, but a significant lack of experience on financial issues.
www.afcar.net14
The Board Structure on Lehman Brother
Definition of Independent Directors at Lehman Brothers:• A director is not considered independent if the director or a family member has been
employed as an executive;• officer at the company within the last three years; • has earned a salary in excess of $100,000 from the company in the last three years;• has been employed as an internal or external auditor of the company in the last three
years;• is an executive officer at another company where the listed company’s present
executives have served on the compensation committee in the last three years;• or is an executive officer at a company whose business with the listed company has
been the greater of 2 percent of gross revenues or $1 million within the last three years
Source: NYSE Corporate Governance Rules. http://www.nyse.com/pdfs/finalcorpgovrules.pdf.
www.afcar.net15
Why did Lehman Fail?
On 15 September 2008, Lehman Brothers Holdings filed for Chapter 11 bankruptcy protection. Its bankruptcy filing listed debts of $613bn, and named banks from Tokyo, Hong Kong, New York, Singapore, Taipei and elsewhere as unsecured creditors owed hundreds of millions of dollars.
There are many causes of Lehman Brothers failure, we could divide them to tree categories as follow:
Causes of lehman Brothers failure
Corporate governance
failures
Technical causes
Others
Lehman Brothers had weak corporate governance arrangements which failed to safeguard against excessive risk taking are partly to blame for the economic crisis. Such failures remained hidden in a prosperous market but the downturn has revealed a number of flaws. The key areas of weakness that have been highlighted are:
• Corporate risk management;
• Board of directors;
• Remuneration scheme; and
• Nomination committees.
Corporate Governance Failure
http://www.charlesrussell.co.uk/UserFiles/file/pdf/Mergers%20&%20Acquisitions/briefing%20note%20%20corp%20gov%20since%20the%20fall%20of%20lehman.pdf
Lehman Brothers had sex committee, one of them was a
Finance and Risk Committee, which consists of the
Firm’s Executive Committee, the CRO and the CFO,
should meet weekly to discuss all risk exposures,
position concentrations and risk taking activities, but it
only met twice in both 2006 and 2007.
Risk Management
LEHMAN BROTHERS, “Quantitative Risk Management Policy Manual”, September 2007, P. 3.
Sores:- Grant Kirkpatrick, “The Corporate Governance Lessons from the Financial Crisis”, UNCTAD, P. 68
Timothy Geithner (Secretary Of The Treasury),said in his
report, “Lehman’s plunge into high-risk businesses in the
years before its bankruptcy has become a familiar story.
During this period of aggressive growth, Lehman developed
significant exposures to risky subprime lending,
commercial real estate, structured products, and high-risk
lending for leveraged buyouts. Importantly, the Valukas
Report indicates that Lehman repeatedly breached its own
risk concentration limits in pursuit of higher earnings”.
Risk Management
Treasury Secretary Tim Geithner
http://newsroom-magazine.com/2010/government-agencies/finance-and-banking/lehman-brothers-a-case-study-in-our-systems-failures/
NEW YORK (CNNMoney.com), Failings by Lehman
Brothers executives and its auditor led to the bank
collapse that unleashed the worst of the financial crisis.
According to a report by a court-appointed investigator,
“Lehman repeatedly exceeded its own internal risk limits
and controls," and a wide range of bad calls by its
management led to the bank's failure, says the report,
authored by examiner Anton Valukas.`
Risk Management
Anton Valukas, (Chicago Based Lawyer) said in his report, the bankruptcy examiner's massive report on the collapse of Lehman Brothers has found "credible evidence" that top executives, including the Chief Executive, approved misleading statements and used accounting gimmicks as drugs to hide the truth from investors and the public. Worse, the report raises serious questions about the behavior of auditors and regulators, who are supposed to protect the public. Specifically, the report's revelations include:
Inside Lehman Brothers, some executives were very concerned about the firm's Enron-like accounting practices as the company headed to the brink in September 2008. In May 2008, Matthew Lee, a former Lehman senior vice president wrote a letter to senior management warning that the company may have been masking the true risks on its balance sheet. His warnings, revealed in the bankruptcy report, show that Lehman's auditors knew of potential accounting irregularities and allegedly failed to raise the issue with Lehman's board.
Risk Management
http://www.linkedin.com/answers/financial-markets/equity-markets/MKT_EQU/645169-6828686
Lehman Brothers adopted a new strategy to overcome
their problems but this led to business risks because its
investments in long term assets like the commercial
real estate, private equity and leveraged loans had
more vague prospects and were less liquid than its
usual investments.
Risk Management
“Corporate Governance Of Lehman Brothers”,
http://www.oppapers.com/essays/Corporate-Governance-Of-Lehman-Brothers/687796
The House of Representatives Committee offered the
following observations on the composition of the
board: “Nine are retired. Four of them are over 75
years old. One is a theater producer, another a
former Navy admiral. Only two have direct
experience in the financial services industry”.
Board of directors
Sores:- “Getting Bank Governance Right -The bank board member’s guide to risk management oversight”, Deloitte, 2009, P. 4
http://www.deloitte.com/assets/Dcom-SouthAfrica/Local%20Assets/Documents/ZA_fsi_BS_GettingBankGovernanceRight_160810.pdf
• Board of directors at Lehman Brothers were paid well for their services in fees that
range from $325,000 to $397,000.
• Independent directors may lack the incentive and the time to take care of the
corporation, because, most of them were very busy and had many responsibilities.
For instance, Marsha Johnson Evans serves as a director of Weight Watchers
International, Huntsman Corporation and Office Depot, as well as chairman of
Lehman’s nominating and governance committee and a member of both the
compensation committee and the finance and risk committee.
Board of directors
http://finlayongovernance.com/?p=485
A study from researchers at Harvard University,
“The Wages of Failure: Executive Compensation at Bear Stear
ns and Lehman 2000-2008,”
shows that the top executive managers of Lehman Brothers
received about $1 billion respectively from cash bonuses and
equity sales between 2000 and 2008.
The Board at Lehman Brothers awarded total remuneration of
close to $500 million to Chairman Fuld, just four days before
its collapse and following an announcement that the firm lost
almost $4 billion in the third quarter, Fuld told the media that
"the Board's been wonderfully supportive."
Remuneration scheme
http://journalistsresource.org/studies/economics/corporations/executive-compensation-at-bear-stearns-and-lehman/
http://siteresources.worldbank.org/FINANCIALSECTOR/Resources/J3-LehmanBrothersCaseStudy.pdf
• Fuld (CEO) received nearly half a billion dollars in total compensation Between 1993 and 2007.
• In 2007, Fuld earned a total of $22 million, including:- a base salary of $750,000;- a cash bonus of $4.25 million; and- stock grants of $16 million.
• The staff received a disproportionately high percentage of their pay in Lehman stock and options. When the firm went public, employees owned 4 per cent of the firm, worth $60m. By 2006, they owned around 30 per cent, equivalent to $11billion, at least on paper.
Remuneration scheme
Four of the ten member board at Lehman
Brothers were over 75 years of age and
only one had current financial sector
knowledge.
Nomination
http://www.fide.org.my/publications/articles/0013_OECD.pdf
• One of the main failure cases in Lehman Brothers was the misbehavior of top
executives and the inaction of both the board and the auditing firm (Ernst & Young).
• There are many similarities between the collapses of Enron in 2001 and Lehman
Brothers in 2008, that they managed to reduce leverage on the right-hand side of the
balance sheet and, at the same time, reduce assets on the left-hand side. In Lehman
Brothers, Repo 105 transactions doubled between late 2006 and May 2008, were
known inside the corporation, exceeded the firm's self-imposed limits and typically
happened at the end of each quarter, when financial information had to be released.
Technical Causes of Lehman Brothers failure
Arturo Bris, “THE LEHMAN BROTHERS CASE, A corporate governance failure, not a failure of financial markets”, May 2010,, P. 2-3.
• Lehman in the last year was unable to retain the
confidence of its lenders and clients, because it did not
have sufficient liquidity to meet its current obligations,
and on two consecutive quarters with huge reported
losses, $2.8 billion in second quarter 2008 and $3.9
billion in third quarter 2008, without news of any
definitive survival plan.
Technical Causes of Lehman Brothers failure
http://lehmanreport.jenner.com/VOLUME%201.pdf
• The Wall Street equivalent of a coroner’s report, mention that Richard S. Fuld Jr, Lehman’s former chief executive, certified the misleading accounts, the report said.
• Mr. Valukas (one of the examiner) wrote in the report “Unbeknownst to the investing public, rating agencies, government regulators, and Lehman’s board of directors, Lehman reverse engineered the firm’s net leverage ratio for public consumption,”. The report states that Mr. Fuld was “at least grossly negligent”.
• Henry M. Paulson Jr., who was then the Treasury secretary, warned Mr. Fuld that Lehman might fail unless it stabilized its finances or found a buyer.`
Misleading
Henry M. Paulson Je.Shannon Stapleton/Reuters
http://www.nytimes.com/2010/03/12/business/12lehman.html
Lehman Brothers filed for many reasons, corporate governance failures were the
most important, especially risk management.
Lehman Brothers failure and other failures that happened in the financial crisis will,
in turn, spawn a new wave of corporate governance reforms.
Conclusion
http://www.law.upenn.edu/cf/faculty/jfisch/workingpapers/77UChiLRev923(2010).pdf