“….On September 15, 2008, Lehman Brothers filed for bankruptcy. 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 Brothers Holdings Inc. – Too big to fail?
Lehman Brothers Holdings Inc. (former NYSE ticker symbol LEH) /ˈliːmən/ was a global financial services firm. Before filing for bankruptcy in 2008, Lehman was the fourth-largest investment bank in the United States (behind Goldman Sachs, Morgan Stanley, and Merrill Lynch), doing business in investment banking, equity and fixed-income sales and trading (especially U.S. Treasury securities), research, investment management, private equity, and private banking. Lehman was operational for 158 years from its founding in 1850 until 2008.
On September 15, 2008, the firm filed for Chapter 11 bankruptcy protection following the massive exodus of most of its clients, drastic losses in its stock, and devaluation of assets by credit rating agencies, largely sparked by Lehman's involvement in the subprime mortgage crisis, and its exposure to less liquid assets. Lehman's bankruptcy filing is the largest in US history, and is thought to have played a major role in the unfolding of the late-2000s global financial crisis. The market collapse also gave support to the "Too Big To Fail" doctrine.
Some time back, I read a research report about Lehman collapse. The work was done by Young Ah Kim and was published in Illinois Business Law Journal (https://publish.illinois.edu/illinoisblj/2016/04/28/the-agency-problem-of-lehman-brothers-board-of-directors/#_ftn8) in April, 2016. I am sharing certain portion from the said research relevant to corporate governance, which failed in Lehman and could be one the reasons for collapse, as understood in hindsight.
The research says – “Lehman Brothers is often cited as an example of corporate governance failure largely due to poor oversight by the board.”
“However, Richard Fuld (CEO of Lehman at the time of collapse) has different thought on this and seven years later in 2015, he gave a speech at a conference in New York. Fuld spoke about Lehman’s risk management, as quoted in The Wall Street Journal: “Regardless of what you heard about Lehman’s risk management, we had 27,000 risk managers because they all had a piece of the firm.”
The report questions “Why did Lehman’s board of directors not effectively oversee Lehman and leave it bankrupt? Their responsibilities are the oversight of and advisory to the company. After Lehman Brothers collapsed, many observers have pointed out that it should not have taken excessive debts, diversified product portfolio and the board of directors should have monitored its strategy and risk management more carefully. All of the root causes of Lehman’s failures can be traced back to the dysfunction of the board of directors and the agency problem.”
The reports critically examines the role and failure of Independent Director and says –
“In Lehman, 8 out of 10 directors met the independence of standards of the NYSE in 2006, but they lacked the financial expertise and failed to reliably monitor Lehman. For example, the finance & risk committee met only two times a year and the compensation committee met more times (eight) than the audit committee (seven). Berlind was a theatrical producer, and Evans was a career officer and rear Admiral in the United States Navy. Retired CEOs’ professional experience include Sotheby’s, Vodaphone Group, IBM, Telemundo Group, which are not financial services areas. Until 2006, Lehman’s board included Dina Merrill, an 83-year-old actress. In addition, there were no current CEOs of major public corporations and former CEOs were well into retirement. Did the board properly understand the complexity and severity of financial markets well enough to weather the storms when the financial market slowed down? Could these “independent” directors who did not have most updated financial expertise represent the shareholders’ best interests? Did they exercise fully their fiduciary duty that they owe to Lehman and act in good faith in exercising their oversight responsibilities solely in the best interests of Lehman’s shareholders?”
It may happen that most of the public listed entities (all size) would comply with the regulatory requirement for the composition of the board of directors and committees but ‘irrelevance’ of such people or lack of training of such people may make the whole process redundant. It may be completely ineffective board as far as Independent directors are concerned when they are not ‘relevant’ or not trained for that board. Most of the boards are decorated with good names but they become ineffective or they have failed when it comes to corporate governance. In the recent days, we have seen a large number of Non Performing Assets (NPA) in Indian banking system. To what extent the board of directors should be held responsible, particularly independent director for both the side – borrower and lender, it’s a question to be examined in detail carefully.
Lehman didn’t fail due to noncompliance. In most of the cases, corporate governance is understood a system of ‘legal compliance’ and not beyond that. But a good corporate governance contributes to shaping a company and its business beyond compliance. For the board of directors and particularly for Independent Directors, take away from Lehman Brothers failure would include the following quick points:
i. It should be understood very well by the directors that there is no doctrine – ‘too big to fail’. In fact, when it is too big, the impact is also too big of something going wrong. Hence when the going is good, they (directors) need to be extra careful and most of the times, wrong decisions are taken during the best times.
ii. Directors must examine ‘risk’ for every business plan in depth and in case, they need some external assistance, they must seek the same to examine the plan. Risk, de-risk process is a must for every company.
iii. Directors must ask the executive management to build an information architecture – to get the right and accurate information at the right time and with the right periodicity.
iv. Directors must set up a process of information dissemination to the stakeholders which conveys the necessary risk factors associated with the business of the company.
v. Board composition and recruitment of Independent Directors – they must have some relevance to the business and not the sole criteria of the promoter’s familiarity.
vi. Independent Director must insist for the proper familiarization program by the company in order to understand the business of the company and it should be on regular basis.
vii. Independent director must keep an eye on the information about the company in the public domain in general to sense the direction and must seek the necessary information.
In conclusion, the report says –
“… directors should keep in mind that they are bound by the fiduciary duty to ensure that they govern the company in the best interests of the company and its shareholders, not themselves, including the duty of care and the duty of loyalty to the company.”
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