Much like the classic “I Love Lucy” episode featuring Lucy and Ethel becoming overwhelmed by an ever-quickening conveyor belt of chocolates, directors can be left feeling overwhelmed by changes coming at them, said Henry Hu, director of the SEC’s Division of Risk, Strategy and Financial Innovation, the keynote speaker at last night’s NACD Directorship 100 Forum in New York City.
“Wall Street engineers must get ahead of what comes down the pike,” said Becky Quick, co-anchor of CNBC’s “Squawk Box” who introduced Hu and noted that SEC chair Mary Schapiro tapped Hu to head the first new division created by the Commission in 40 years because she had “identified someone that first started warning us about derivatives.”
Hu focused on his “decoupling” concept as well as the importance of the Dodd-Frank Act, which he noted is the “most comprehensive change in generations… representing a new era for corporations and boards that introduces new challenges and new opportunities. It is important to get the balance between corporate governance and financial innovation right.”
“I have argued that a new modern process has developed along with the emergence of modern derivatives,” Hu continued. The decoupling “phenomenon” occurs in all tranches, and its core mechanism may have played a role in the financial crisis. “The decoupling of voting rights from equity has changed the traditional idea of a one-to-one proportion of votes to shares, allowing – in extreme versions – voters with significant economic interest but no interest in the company’s success.
“Wouldn’t it be kind of neat if you were a takeover artist and could take a large share of a corporation without reporting it?” Hu asked the audience of 300. “Many takeover artists have,” in situations such as those where a holder “cancels equity swaps, and suddenly the hidden ownership becomes public.”
“It is altogether different when dealing with a Jimmy Stewart from It’s a Wonderful Life banker for loans,” Hu mused about the consequences of debt decoupling in the context of individual borrowers, noting that one “cannot take as much comfort in the business judgment rule” especially given the recent economic challenges within the United States and overseas.
Boards must recognize the psychological tendency to focus on the things one already understands, and break from that tendency. “If you’re an expert in law, then you look at everything from a legal perspective. Say you’re talking about issues that you cannot quantify, that are outside of your expertise. Many would say ‘if it was important, I’d understand it.’”
“I don’t mean to suggest that you should avoid risk,” he said, quoting Milton Friedman: “The safest place in the world is a jail cell.”
Hu’s comments were particularly relevant to the audience of the NACD Directorship 100 Forum, who had gathered to pay tribute to he 100 most influential players in corporate governance. NACD Directorship recognized “Hall of Fame” honorees: H. Rodgin Cohen, senior chairman of Sullivan & Cromwell; Edward A. Kangas, chairman of Tenet Healthcare and director of United Technologies, Intuit, Hovnanian Enterprises and Eclipsys; Alan G. Lafley, special partner, Clayton Dublier & Rice, General Electric director; Carol J. Loomis, senior editor-at-large, Fortune; and Paul A. Volcker, head of the President’s Economic Recovery Advisory Board.