Few things make executives more nervous than a board of directors determined to show it is responsive to dissatisfied shareholders.
Given the market performance of banking companies over the past year, dissatisfaction is pervasive, and directors in those circumstances often conclude the best or only way to let shareholders know they are being heard is to make heads roll.
From Wachovia Corp. to Citigroup Inc., from Downey Financial Corp. to Washington Mutual Inc., boards have shaken up executives suites — in part to bring in new blood and fix broken banking operations, but also to deflect blame, analysts said.
"I think they feel more empowered, but in many cases I also think they are scared — they were supposed to be minding the shop when a whole lot of credit issues seemed to just creep up on them without being noticed," said Mark Fitzgibbon, research director at Sandler O'Neill & Partners LP. "Boards are looking to blame somebody, and CEOs and top management will continue to be the targets. I think we've just seen the tip of the iceberg."
The role of the corporate director has evolved over many years from sinecure to fiduciary, especially under the Sarbanes-Oxley Act. But the passage of that reform legislation coincided with an extended run of profitability in the banking industry, and discussions about the consequences of weak corporate governance were mostly theoretical. No longer.
Banking company directors "realize they now have to be on top of things, have to be the ones who make sure management is actually accounting for risk," said Richard X. Bove, an analyst at Ladenburg Thalmann & Co. "Of course, that always should have been the case, but at least they are stepping up now."
A frequent result of a board stepping up is an executive stepping down.
Downey Financial said on July 1 that it had parted ways with its president, Frederic R. McGill, who had been on the job less than a year. The Newport Beach, Calif., thrift company said it and Mr. McGill had agreed to "terminate" his employment; it did not say why and declined an interview request.
Analysts said directors at Downey, whose stock has lost 90% of its value over the past year, looked to Mr. McGill to curb loan losses. The California housing market floundered, Downey's mortgage troubles continued to mount, and by letting Mr. McGill go the company likely was signaling to investors that it believed he did not do enough to minimize the damage, analysts said.
Several law firms are trying to bring class actions against Downey, claiming it knew the full scope of its troubles but failed to disclose them — sticking shareholders with losses.
"The board appears nervous; they probably felt they had to find a fall guy," said an analyst who spoke on the condition of anonymity to avoid alienating the company.
John C. Coffee, a professor at Columbia Law School and a former corporate attorney, said that when business plans fail, often the onus is on the board to remove the executives who failed to do their jobs. He said he expects to see more executives fall this year. In some cases it would be long overdue, he said. Some boards "simply sat there and took assurances from management" while core business lines were deteriorating.
In this down cycle, Prof. Coffee said, some boards, while hiring new executives, may also need to impose strict new rules on investing or lending practices. If Bear Stearns and Countrywide Financial Corp. had not been sold this year, he said, the boards of each would likely have considered new internal codes that would have prevented executives from gambling on certain high-risk loans or investments.
"In some cases, a board may need to become the company's superego. They can't just replace the CEO and then go back to business as usual," Prof. Coffee said.
Citi was among the first of the major banking companies to act. Charles O. Prince, facing substantial pushback from shareholders, resigned as chairman and CEO last November; a month later the New York company split the two roles. That allowed new CEO Vikram Pandit to focus on righting Citi in the face of ballooning writedowns tied to structured products and leveraged loans. But it was also clear that Citi took the step to signal its commitment to strong corporate governance — and that the board, led by new chairman Sir Win Bischoff, would be carefully monitoring Mr. Pandit's performance.
Sir Win emphasized his accountability to investors, saying when he was promoted to chairman that the board would "provide active and effective support toward increasing value and returns for all Citi shareholders."
A Citi spokesman noted last week that the company was continuing to search for new board members with financial services experience as its standing board members retire or decline to stand for reelection.
Karen Shaw Petrou, managing partner of Federal Financial Analytics Inc. in Washington, said boards "need to hold themselves responsible. To do that, they need people among them who understand the industry. It doesn't have to be as hard as it's often made out to be — the board doesn't have to know everything or be involved at every level." That may come as some reassurance to potential directors contemplating Citi's diverse business mix.
A primary board responsibility is "to set clear risk tolerances" and then directors "have to make sure those tolerance levels are followed," Ms. Petrou said. "If the board says X and it turns out to be Y, the board can't just say 'OK' to management."
Some board members have privately commented that investors cannot reasonably expect directors, who typically meet only once a month and sometimes less than that, to spot warning signs that full-time executives missed.
Ms. Petrou commonly advises boards to meet more often and fortify their ranks by seeking candidates with financial expertise. Another increasingly common decision is to seek board chairmen who are independent from management.
Wachovia responded to shareholder demands for a stronger board in May, first by stripping G. Kennedy Thompson of his chairmanship in favor of lead independent director Lanty L. Smith. Less than a month later, the board, led by Mr. Smith, ousted Mr. Thompson and began a search for a successor. That search ended last week with the hiring of Robert K. Steel, a former Treasury Department undersecretary and one-time Goldman Sachs Group Inc. executive, to lead the company.Through spokesmen, Citi and Wachovia directors declined interview requests.
Kerry K. Killinger was stripped of his chairmanship but has so far managed to hold on as CEO at Wamu, which has been pummeled by loan losses in the overheated housing markets in Florida and California. Other executives at the Seattle thrift company have not been as fortunate.
At Wamu, which this year is rapidly downsizing its troubled mortgage business and trying to ramp up its retail bank, shareholder discontent even reached the boardroom, with the April resignation of director Mary E. Pugh. Ms. Pugh had chaired Wamu's finance committee — the group in charge of risk oversight for the mortgage business. Wamu directors declined interview requests through a spokesman.
Stephen Lerner, the director of the Service Employees International Union's Private Equity Project, welcomed the board's more aggressive approach, but said Wamu, which has posted steep losses the past two quarters, must demonstrate that it has a sound profitability plan. "Boards still have to prove they are awake at the wheel," Mr. Lerner said.
