When Harry Met Henry
Spend time with directors and who knows what you’ll find? At the NACD Directorship D100 Forum I caught up with Henry Hu, risk czar for the SEC until next year when he returns to the University of Texas, and famed Madoff whistleblower Harry Markopolos. Both shared their unique insights on how directors should deal with risk and regulation. Hu said financial innovation may upturn the world of corporate governance—by the use of sophisticated derivatives that can make a hedge fund want to place a bet on a company’s decline or even a default.
Perfectly legal. Perfectly absurd. For directors, it’s no longer only about knowing who their shareholders are, but what kind of derivatives they own. To compound the confusion, they may own two contrary instruments, making the net difference the direction.
Harry talked to me about lax oversight in the previous SEC administration when faced with a complex case that had little national media potential; and, of course, the corollary that when a high-profile CEO of a major company wanders into their sights, it’s all-out war. When it comes to public company fraud, Harry also faults boards for not asking the right questions of the C-suite, where the empirical evidence shows the problem starts.
Remedies? Henry and Harry would agree: Boards need to become self regulating. They have to do their homework on the hedge fund universe and its contra mindset. Encourage even greater auditor independence. Oversee compliance. Make life safe for whistleblowers. Directors must direct.
CalPERS’ List
For many years, CalPERS compiled a list of underperformers due to poor corporate governance and targeted them publicly. Its impact on the companies’ stock prices became legendary and the subsequent rise in value was dubbed “the CalPERS effect.”
Now in a recent announcement, the well-known California state pension fund that manages $215 billion in assets said it is “ending its 20-year habit of publicly criticizing poor-performing companies whose stock it owns.”
Instead of posting an annual “nameand- shame” Focus List, CalPERS plans to privately contact corporations that it is unhappy with. CalPERS Board President Rob Feckner said, “The time has come for a more effective approach.”
What is this—a form of kinder, gentler activism?
I think not. I think it is recognition of a boardroom reality. Work with directors and they will work with and for you. Too often, activists feel they must take a divisive approach or the board will simply hunker down. But if we look at such savvy investors as Ralph Whitworth’s Relational Fund (CalPERS seeded it originally) and how successful he has been at showing boards he can have a profound effect on creating value, we see that CalPERS is dumb like a fox.
Chasing headlines is not the same as effective oversight. Feckner is right: Working with boards through coherent dialogue will prove smarter and more effective. CalPERS’ move signals a different tonality for boards and investors. It is to be welcomed and embraced.