Lehman Brothers - Corporate Governance

Collapse of Lehman BrothersBECG ASSIGNMENT

Submitted by:(GROUP 2)AVINASH PANDEY 20131007BHARGAV BHATT 20131008BHAVIK PATEL 20131009DARSHIT PAUN 20131010DHAVAL SHAH 20131011HIMANSHI SINGH 20131012

History of Lehman Brothers

Founded by German immigrant Henry Lehman in Montgomery, Alabama, in 1844.

In 1850, Henry Lehman and his brothers, Emanuel and Mayer, founded Lehman Brothers

Lehman survived them all:

The railroad bankruptcies of the 1800s,

The Great Depression of the 1930s,

two world wars, a capital shortage when it was spun off by American Express in 1994,

and

the Long Term Capital Management collapse and Russian debt default of 1998.

Introduction

The disorderly and costly nature of the LBHI bankruptcy the largest, and still ongoing, financial bankruptcy in U.S. history contributed to the massive financial disruption of late 2008.

The collapse of Lehman Brothers Holdings Inc. (LEH) had a crippling effect on the global economy with the financial crisis escalating to other parts of the world. In the aftermath of this event, financial institutions froze lending activities thereby creating liquidity problems in the shadow banking financial system.

Lehman Brothers

Before bankruptcy: was the 4th largest investment bank in US

Bankruptcy protection: September 15,2008

November 16, 2010: US bankruptcy court stated LBHI directly return $50b plus interest to BOA within 2 weeks

Why it was a scandal?

In July 2008: an overdraft of $65b in one of Lehman accounts.

Accounting manipulation: used device called “Repo 105” to manipulate the financial accounts and made it looks healthier than it was.

Hiding the truth about the amount of their losses to the public

Cause of collapse• Collapse of the Mortgage Backed Securities

• The loss of potential investors

• Rejection for bailout from US treasury, leading to negative market sentiment

• Negative knock on effect

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:

Corporate governance

failures

Technical causes

Others

Cause of Lehman Brothers Failure

Lehman Brothers had six committees, 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

As per Secretary of Treasury(Timothy Geithner) & examiner Antos

Valukas Report –

- Company plunged into High-risk business

- Breached its own risk concentration limits

- Exceeded its own internal risk limits and controls

- Wide range of bad calls by its management

- Chief Executive, approved misleading statements and used accounting

gimmicks to hide the truth from investors and the public

- Auditors knew of potential accounting irregularities, but the company

did not react

- Company’s new strategy had vague prospects and were less liquid than its

usual investments

Treasury Secretary Tim Geithner

Risk Management contd.

Introduction to Corporate Governance

Corporate governance is the system by which companies are directed and controlled.

Corporate Governance parties:

a) Shareholders – those that own the company

b) Directors – Guardians of the Company’s assets for the Shareholders

c) Managers who use the Company’s assets

Four pillars of Corporate Governance:

Accountability

Fairness

Transparency

Independence

• Ensure that management is accountable to the Board

• Ensure that the Board is accountable to shareholders

• Protect Shareholders rights

• Treat all shareholders including minorities, equitably

• Ensure timely, accurate disclosure on all material matters, including the financial situation, performance, ownership and corporate governance

• Procedures and structures are in place so as to minimize, or avoid completely conflicts of interest

Corporate Governance Theories:

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.

Corporate Governance Failure

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

Name Experience

ICHAEL L.

AINSLIEFormer CEO Sotheby’s

JOHN F. AKERSFormer Chairman of International Business

Machines Corporation

ROGER S. BERLIND Theatrical Producer

JOHNSON EVANS CEO American Red Cross

SIR CHRISTOPHER

GENTChairman GlaxoSmithKline

Vice Chairman RKO Pictures / Actress

THOMAS H.

CRUIKSHANKFormer CEO Halliburton

JOHN D.

MACOMBERPrincipal JDM Financial

Professional background of independent board members

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

Numbers of Committees:

Audit Committee

Compensation and Benefits Committee

Nominating and Corporate Governance Committee

Finance and Risk Committee

Executive Committee.

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.

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.

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

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

• 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.

A study from researchers at Harvard University, “The Wages of Failure: Executive

Compensation at Bear Stearns 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

• 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.

http://www.fide.org.my/publications/articles/0013_OECD.pdf

Nomination

• 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).

• 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

• 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

Lehman Brothers failed for many reasons.

• Corporate governance failures

• Inefficient Risk Management

• Creative Accounting/Window Dressing procedures

• Lehman Brothers failure and other failures that happened in the financial

crisis has, in turn, spawn a new wave of corporate governance reforms.

• It has given rise to the evolution of a robust Whistleblower policy

Conclusion

THANK YOU!!