Citigroup

This Tuesday, shareholders and the general public will get a chance to see whether anybody at Citigroup will be held accountable for the catastrophic failure of company management to oversee the colossal risks and the ensuing disaster that has impacted the global economy. That day, at the Hilton New York in midtown Manhattan, the company will hold its annual shareholders meeting. For the price of a Citigroup share of stock (trading Friday at around $3.65 a share), New Yorkers can enjoy (perhaps that isn’t the right word but whatever) theatrics surpassing anything in the neighboring theater district a few short blocks away.

The meeting agenda is chocked full of company and shareholder sponsored resolutions – thirteen in all. All of the proxy advisory services – RiskMetrics, Glass-Lewis, Proxy Governance, et al. – have weighed in with a variety of recommendations on the various proposals, which company executives have opposed.

Perhaps the most important proposals on the day’s agenda are management sponsored: reelection of the company’s board of directors and ratification of the company’s executive compensation plans.

Herein lies the toothless cats in waiting. But Wall Streets vermin have nothing to fear.

What I mean is this: Under our current system set out in the federal securities laws and regulations, shareholders are entitled to vote on an array of issues – executive compensation, directors, corporate governance issues of all shapes and sizes – but company executives are largely free to accept or ignore the outcomes of the election.

If this system were allowed in the presidential election process, George Bush could stay on for four more years if he so choose.

What the . . .

Unless you have been hibernating in a cave in northern Greenland for the last couple of years, you probably already know the facts surrounding the company but let’s recap the highlights of its stunning performance of late.

As was noted by proxy advisor, Proxy Governance, “Citigroup, along with many of its peers, have suffered from over-exposure to an array of complex and risky securities now dubbed toxic-assets. As with most systemic breakdowns, many things went wrong that led to these problems. Central to these problems were excessive risk taking by individuals, poor risk management practices and oversight, and overly aggressive strategies to grow profits – core areas of board responsibility. Such collective failure is notable not only for its price tag but for the fact that it comes despite growing adherence to so-called corporate governance “best practices” and check-the-box processes – it is tragically clear that many boards continue to fail in anticipating and addressing emerging challenges and in aligning the company’s risk taking and risk management activities with its strategic plan.”

These Guys Couldn’t be Elected Dog Catcher, But . . .

Shareholders, led by AFSCME, Change to Win and a number of other union affiliated pension funds have called for a vote against the re-election of the long-term members of the Audit & Risk Management Committee, including former Chair C. Michael Armstrong, former committee member Alain Belda, current Chair John Deutch and members Andrew Liveris, Anne Mulcahy and Judith Rodin. This is a modest request considering the massive ineptitude of these overseers.

During these Committee members’ tenures, the Audit & Risk Management Committee failed to protect shareholders from excessive exposure to credit, market, liquidity and operational risk. According to CEO Vikram Pandit, “Citi’s resources were allocated to activities that did not create enough value for our clients and did not earn adequate risk-adjusted returns for shareholders.”

I think that these shareholders have made a reasonable argument for voting these directors out of their positions and perhaps to a different universe.

So How are Taxpayer Dollars Being Spent at Citi?

Remember earlier this year when Vikram Pandit, Citi’c CEO, sat before a Congressional committee and pledged that he would take only $1 in salary until Citi returned to profitability?  I remember it clearly. Unfortunately, Mr. Pandit has the ability to, ah, shall we say evade the truth when testifying before Congress. While he noted that he would not take a salary until things straightened out at the company, he failed to mention that he would still receive more than $51 million on deferred compensation, stock options and a variety of other non-salary forms of compensation for 2008.

Ooopsie!

Anyway, as required of all TARP participants, there is an advisory vote on the company’s executive compensation program presented for shareholder approval. The American Recovery and Reinvestment Act (ARRA) of 2009 added provisions to the Treasury Department’s Troubled Asset Relief Program’s (TARP) Capital Purchase Program – a $700 billion emergency initiative approved by Congress to infuse capital into the banking sector – requiring that, among other things, participants submit an advisory vote on executive compensation to shareholders.

This proposal is advisory in nature. Regardless of the vote outcome, the company’s board is under no obligation to reconsider its compensation awards to its executives.

As is obvious to most investors, the company has performed abysmally this last year. By all measures, it has substantially trailed its peers and the S&P 500 by every measure. At the same time, the company’s CEO and other top executives have been paid handsomely, significantly higher than the median compensation paid to other executives at peer companies. While the top executives at Citi graciously gave up their salaries, their total compensation packages remained remarkably high with the CEO, Vice Chairman and Co-Head of Global Markets receiving $51M, $13M and $20M respectively.

So who are the toothless tigers? Shareholders of course. This is not to blame them as I am certain that, if given half a chance using real tools for corporate change, they would rip these executives  from limb to limb. That said, it will be fascinating to see how the meeting plays out if only to see how the play ends.

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2009 proxy season is fast approaching and it promises to be a doozy. Not since the Great Depression have we seen such a systematic failure of the capital markets and such widespread corporate failure at all levels. Investors are learning the harsh lessons of risk as they review their investment portfolios and 401k statements. As shareholder proxies arrive in the mail in the coming weeks, it will be interesting to see how shareholders respond to corporate management requests for their support on a range of issues up for votes.

Rumors are flying that a number of institutional investors are launching “Vote No” campaigns at several financial institutions. The targets for these campaigns against directors at these companies are obvious to anyone not in a coma for the last six months: Citigroup, Bank of America, AIG and so on.

For readers unfamiliar with what a “Vote No” campaign is, let me enlighten you.

A “Vote No” campaign is a call from a shareholder or group of shareholders in a company to vote no for some or all of the directors standing for election at a public company. Such a vote is symbolic in many ways since the company is under no obligation to remove a director if her or she receives a majority of no votes cast against him or her. However, the symbolism is significant in that it reflects a dramatic vote of no confidence in the directors slated for a vote no campaign.

Take for example the slate of directors at Citigroup up for a vote this year. Titans of industry, these directors oversaw a disaster inflicted on not only shareholders at Citi but at their own companies and institutions as well. The larger impact of their failure to manage Citi managers is all too obvious.

So who are the directors at Citibank? Here is the list:

C. Michael Armstrong
Chairman, Board of Trustees
Johns Hopkins Medicine, Health Systems and Hospital

Alain J.P. Belda
Chairman and Chief Executive Officer
Alcoa Inc.

John M. Deutch
Institute Professor
Massachusetts Institute of Technology

Jerry A. Grundhofer
Chairman Emeritus
U.S. Bancorp

Andrew N. Liveris
Chairman and Chief Executive Officer
The Dow Chemical Company

Anne M. Mulcahy
Chairman and Chief Executive Officer
Xerox Corporation

Michael E. O’Neill
Former Chairman and CEO
Bank of Hawaii Corporation

Vikram S. Pandit
Chief Executive Officer
Citigroup Inc.

Richard D. Parsons
Chairman
Citigroup Inc.

Lawrence R. Ricciardi
Senior Vice President and Advisor to the Chairman, Retired
IBM Corporation

Dr. Judith Rodin
President
Rockefeller Foundation

Robert L. Ryan
Chief Financial Officer, Retired
Medtronic Inc.

Anthony M. Santomero
Former President
Federal Reserve Bank of Philadelphia

William S. Thompson, Jr.
Chief Executive Officer, Retired
Pacific Investment Management Company (PIMCO)

For those of this exclusive club who still hold day jobs, their employers should initiate steps to fire them immediately. For instance, if a janitor at Xerox Corporation been as negligent as Anne Mulcahey, Xerox’s CEO, he would have been escorted from the building and directly into the back seat of a police cruiser.

Shareholders at Citi and other institutions responsible for the greed and shortsighted profiteering have a choice when they vote their proxies. Whether they take the time to send a message to management remains to be seen.

For a complete rundown on the directors at Citigroup, go to the SEC Edgar database located here.

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In the video below a group of European nonprofit organizations asserts that if a bank claims to respect the environment and human rights, then it should not invest in the Kashagan oil project in Kazakhstan. The project is underway in the fragile ecosystem of the Northern Caspian Sea. The groups responsible for the video claim that instead of reducing poverty and bringing development, the project has negatively impacted the health and safety of thousands of local people and species.

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A noontime roundup of business and politics.

It’s a Bird, It’s a Plane! No, It’s HubrisMan!

In today’s Financial Times, the new Treasury Secretary, Tim Geithner had to make the call to Citibank officials to tell them that it might not be a wise idea to buy that $50 million jet they recently ordered. It seems that executive hubris know no limits at Citibank.

FT.com

Santander Covers It’s Madoff Losses

Banco Santander, the Spanish bank, announced that it would repay victims of the Bernie Madoff fraud in an attempt to stave off lawsuits and preserve its reputation. 

FT.com

Sen. Chris Dodd Get’s Bailout Money?

OpenSecrets.org reports that Senator Chris Dodd, Chairman of the Senate Committee on Banking, Housing and Urban Affairs and is now charged with shaping legislation to jump-start the economy and help floundering companies is getting some bailout money of his own, to wit:

Dodd’s most generous donors include many of the companies that have filed for bankruptcy or sought government help over the last six months: Citigroup ($428,300), Morgan Stanley ($211,300), American Insurance Group ($280,250) and Lehman Brothers ($154,300). Despite the companies’ support, when the Senate was called on this month to release the second half of the $700 billion bailout money, Dodd called for stronger oversight provisions and limits on executive compensation for the companies receiving a handout.

Senator, perhaps the guys at Citigroup will let you borrow their plane.

Opensecrets.org

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Yesterday, the Congressional Oversight Panel (COP) released its second monthly report on the expenditure of Troubled Asset Relief Program (TARP) funds authorized by Congress in the Emergency Economic Stabilization Act of 2008 (EESA). The report documents the efforts to get answers to the questions posed in the Panel’s first report, and details both the answers received from Treasury, and the many questions that remain un-addressed or un-answered.

“Hullo Houston, we’ve got a problem.”

As was noted in the report, “[b]ecause the questions we asked one month ago are important as ever, in this second report we lay out exactly what questions have been answered, what haven’t been answered and why these questions are important,” said Elizabeth Warren, the Chair of the Oversight Panel. “The American people have a right to know how their taxpayer dollars are being used, and so far, they have not gotten the transparency and accountability they deserve.”

Apparently the Treasury Department does not see this as a problem.

TARP and the Congressional Oversight Panel

On October 3, 2008, Congress provided the U.S. Treasury with the authority to spend $700 billion to stabilize the U.S. economy. Congress created the Office of Financial Stabilization (OFS) within Treasury to implement a Troubled Asset Relief Program (TARP). At the same time, Congress created a Congressional Oversight Panel (COP) to “review the current state of financial markets and the regulatory system.”

COP is empowered to hold hearings, review official data, and write reports on actions taken by Treasury and financial institutions and their effect on the economy. Through their reports to Congress and American taxpayers, the COP is mandated to:

• Oversee Treasury’s actions
• Assess the impact of spending to stabilize the economy
• Evaluate market transparency,
• Ensure effective foreclosure mitigation efforts
• And guarantee that Treasury’s actions are in the best interest of the American people.

Lastly, Congress has instructed COP to produce a special report on regulatory reform that will analyze “the current state of the regulatory system and its effectiveness at overseeing the participants in the financial system and protecting consumers.”

So far, so good.

The Panel’s Second Report

However, in today’s report we now find that the Treasury Department is choosing to ignore the Panel’s queries into how it is managing the distribution of more than $700 billion in taxpayer money. I won’t go into great detail about all of the questions that the Treasury Department has so far failed to answer. However, it’s worth noting some of the more critical questions that we all want an answer to but have received no response from Treasury. As the report notes:

The Panel still does not know what the banks are doing with taxpayer money.  Treasury places substantial emphasis in its December 30 letter on the importance of restoring confidence in the marketplace.  So long as investors and customers are uncertain about how taxpayer funds are being used, they question both the health and the sound management of all financial institutions.  The recent refusal of certain private financial institutions to provide any accounting of how they are using taxpayer money undermines public confidence.

For Treasury to advance funds to these institutions without requiring more transparency further erodes the very confidence Treasury seeks to restore.  Finally, the recent loans extended by Treasury to the auto industry, with their detailed conditions affecting every aspect of the management of those businesses, highlights the absence of any such conditions in the vast majority of TARP transactions.  EESA does not require recipients of TARP funds to make reports on the use of funds.  However, it is within Treasury’s authority to make such reports a condition of receiving funding, to establish benchmarks for TARP recipient conduct, or to have formal procedures for voluntary reporting by TARP recipient institutions or formal guidelines on the use of funds.  The adoption of any one of these options would further the purposes of helping build and restore the confidence of taxpayers, investors, and policy makers.

On a practical level, where did the $100 billion or so given to AIG and its creditors go? So far, the Treasury Department isn’t saying. What is Treasury’s vision of the problem? So far, no word. What does Treasury think the central causes of the financial crisis are and how does its overall strategy for using its authority and taxpayer funds address those causes? Mums the word.  Is Treasury seeking to use TARP money to shape the future of the American financial system, and if so, how? Apparently, this is none of our taxpaying business.

The full report can be found here. Be forewarned, this report is not for the faint of heart.

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It’s the time of year to reflect on all that we have and to give thanks. But this year, finding reasons to be thankful is a little harder than usual.

The economy has been in recession for more than 12 months. National housing prices have had their worst annual decline since 1968. Nearly 2 million jobs have been lost with more unemployment on the way. The S&P 500 index has dropped more than 40% and that’s the good news for investors. And the Fed has slashed interest rates to near zero, a sign that things are truly grim out there in the economy.

Here are some year-end musings related to business and the economy…

Missed chances. Goldman Sachs alum Gary Gensler had his chance to step in and provide needed regulation involving credit default swaps and other complex securities during the Clinton Administration. He didn’t. Why then is Obama trusting him to oversee the high-risk derivatives market 10 years later? I’m not really sure, but maybe he’s taking his queue from Adlai Stevenson who once famously said on the campaign trail: “I believe in the forgiveness of sin and the redemption of ignorance.” But in all fairness, Gensler does have two big things going for him: he was a senior adviser to Senator Paul Sarbanes, one of the primary architects of the Sarbanes-Oxley Act, and he wrote a book that argued active trading is an inefficient strategy for individual investors and that individuals should stick with indexing and using exchange traded funds. So maybe he isn’t all that wrong for the job.

Oops, can I have a mulligan? Recently, the WSJ asked four management professors for nominees of CEOs who kept their companies afloat in 2008. Their selections included Anne Mulcahy of Xerox Corp. She may or may not deserve the award for “CEO of the Year” in 2008. I’ll refrain from passing judgment on that. However, I’m pretty confidant that she won’t be winning any “Director of the Year” awards anytime soon, unless it’s handed out by The Onion. Consider this distinguished track record: Mulcahy served on the board of Fannie Mae through much of the housing bubble and then left in 2004 to go and serve on the board of Citigroup where she remains a member of the audit and risk committee. My advice for her: stick to making copiers.

Just how useful is the “risk management” industry anyway? Two years ago, the business of “financial risk management” was all the rave. At the time, I had a front row seat to this hoopla when one of the leading risk companies in New York acquired my firm and then went public in a splashy and overpriced IPO. Firms like Risk Analytics, RiskMetrics Group, Institutional Risk Analytics (you get the idea here) were getting quoted all over the mainstream financial press for their brilliant insights on how to better manage financial risk. These firms are loaded with PhDs and financial wizards who spend their days (and probably nights) doing Monte Carlo simulations and event stress testing on investment portfolios. Most investors – including pension funds – don’t really understand what they do but hire them anyway because they think they should. Unfortunately for their clients – many of which were the same Wall Street firms at the epicenter of the financial crisis – the gurus of risk analysis apparently missed identifying the mother of all meltdowns – the U.S. housing bubble. Makes you wonder about the usefulness of using highly complex computer simulations to assess risk when these models can’t spot a crumb on the end of a nose. Personally, I prefer good ole’ fashion intuition grounded in deep experience and common sense, thank you very much.

A good dose of dickensian irony. His name alone should have raised concerns. Former Nasdaq chairman and once widely respected investment guru Bernie “made off” Madoff pulled off the grandest and most audacious of Ponzi schemes to date. While this may have been the biggest fraud so far it won’t be the last you can be sure. This sad tale should force all aspiring Buffets to revisit rule Numero Uno in the Investor Handbook – DIVERSIFICATION. This maxim refers to investment styles, securities AND investment firms. Never trust one person or even one institution with ALL your money. Always spread the wealth, that is what little you have left after this year is over.

One big lump of coal in the stocking. Credit Suisse deserves special kudos for bringing the monkeys of the Wall Street carnage back down to reality. The Swiss firm just announced that it would pay its investment bankers up to 80% of their 2008 year-end bonuses in the form of “illiquid junk bonds, mortgage-backed securities and corporate loans” instead of cash or stock, as is typically the custom. In other words, their employees are going to eat the toxic pudding they cooked up for the rest of the market. Happy stomach aches guys and gals! This move is beautifully punishing in design and will hopefully take us one step closer in breaking the “tails I win, heads I also win” mentality on Wall Street.

Top of the Heap. Of the 11,585 mutual funds tracked by Morningtar Inc., all but ONE lost money in 2008. APX Midcap Growth Fund was the lone exception and it posted a 0% return for the year. Does any more really need to be said?

We all have one thing to be thankful for this Christmas – 2008 is almost behind us.

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The Wall Street bailout legislation, formally known as the Emergency Economic Stabilization Act of 2008, includes limits on compensation for executives of companies receiving taxpayer support.  So what does this mean for taxpayers who are footing the bill?

Not much.

Unfortunately, as drafted the provisions are practically meaningless and will do little to limit the gross payouts already available for these executives. Section 111 of the Act only restricts compensation paid to the top five executives at these companies. In addition, it provides for the recovery, or “claw back,” of ill gotten compensation, that is, performance pay received based upon materially inaccurate financial information.

The “big” provision that has both Republicans and Democrats squealing to their constituents is the provision in the Act that bans payments of “golden parachutes.” These are executive severance agreements that usually pay executives when there is some sort of change in control in the company or, as is often the case, when the executive is fired.  This later provision only applies as long as the federal government holds an equity or debt position in the company.

As noted in last week’s Wall Street Journal, the stakes are significant. The paper reported that executives of financial institutions receiving federal assistance are owed more than $40 billion for past years’ pay and pensions.  Deferred compensation coming due includes $11.8 billion at Goldman Sachs Group Inc., $8.5 billion at J.P. Morgan Chase & Co., and $10 billion at Morgan Stanley.

Since most of these firms haven’t set aside the cash required, they are a drag on current earnings and will be paid out of the corporate coffers.

The liabilities are an essentially a hidden obligation. Even when the debts to their executives total in the billions, most companies lump them into “other liabilities” and only a few of the companies identify amounts attributable to deferred pay.

In today’s Financial Times, it was noted that these Wall Street firms have promised not to use public support to pay these executives’ bonuses.  Bank of America, Bank of New York, Citigroup, Goldman Sachs, JPMorgan Chase, Merrill Lynch, Morgan Stanley, State Street and Wells Fargo all promised to pay salaries and bonuses from existing cash resources.

So lets walk through this scenario and look at the situation at Morgan Stanley.

The company received a capital infusion of $10 billion from the federal government. They stick their newfound money in their corporate pocket (this is a really big pocket by the way) along with their other cash reserves. Let’s say that tomorrow is “bonus day” at the company.  Colm Kelleher, Morgan Stanley’s Chief Financial Officer reaches deep into the company “pocket” and pulls out $21,015,689, which he intends to use to pay himself (this is the total compensation that Mr. Kelleher received in 2007 according to company filings).

“Ooops! That looks like “government” money. Back in it goes,” he muses. Digging around for “loose change,” he eventually finds some “corporate” money and marches off to his bank in the Hamptons where he can console himself over the terrible financial crisis facing America.  This shell game would be laughable if it weren’t our money!

Meanwhile, our leaders in Congress are calling on the government to tighten restrictions on executive pay for these institutions receiving our money. House Speaker Nancy Pelosi and Senate Leader Harry Reid are wringing their hands with concern.  If their last attempt at reining in executive compensation is any measure, we shouldn’t expect real reform anytime soon.

The task of holding corporations responsible for grossly excessive executive pay falls squarely on shareholders. The only problem is that, in years past, the Securities and Exchange Commission has prevented shareholders from raising compensation issues in the form of shareholder resolutions, arguing that such matters constitute “ordinary business” that is exempt from proper shareholder consideration. Let’s hope that, given the massive public policy issues raised by using public funds for executive compensation, the SEC will reconsider its policy in regard to this important matter.

Stay tuned.

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Editor’s note: This article is the third installment in a four-part series on the rise of sovereign wealth funds and what they mean for U.S. investors. Part IV will appear next Friday on GIW.

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Riches in the Sands of Syriana

If only T. E. Lawrence were alive today, he no doubt would be smiling. The British intelligence officer memorialized as “Lawrence of Arabia” for leading the successful Arab revolt against the Ottoman Turks during World War I would surely need a tour guide if he were to return to his old stomping grounds of Cairo, Amman or Damascus. What was once a backwater of political in-fighting among warring Arab clans has emerged a century later as one of the geopolitical “hot spots” of the modern world. Today’s Middle East is a far cry from the world Lawrence of Arabia knew and loved.

The reason, we all know, is simple – oil. And lots of it. The Persian Gulf states are in fact so flushed with it that their export earnings from the commodity has been the single largest source of wealth creation in modern history. Virtually every major oil-bearing country in the region sponsors its own sovereign wealth fund to help manage these growing reserves. Current estimates suggest that those funds derived from oil and gas export revenues account for one-half of the total assets held by all SWFs around the world.

While sovereign funds have existed since the 1950s (the Kuwaiti Investment Authority was the first to be established in 1953) their size and influence worldwide has increased dramatically over the past two decades. In 1990, sovereign funds held about $500 billion. Today, the current total is estimated to be $3 trillion and based on the likely trajectory of current accounts this sum could surpass $10 trillion as early as 2010.

It may surprise some to learn that the Middle East, not China, is at the epicenter of this growth trend. The Carlyle Group declares that the Middle East is now the primary destination for private equity deals and the British bank HSBC estimates that as much as one-third of all project finance involves Middle Eastern projects. According to the U.S. Government Accountability Office (GAO), 28 of the 48 SWFs have been created since 2000, primarily in countries whose foreign exchange reserves are growing through oil revenues or trade export surpluses. The preponderance of those are in the Middle East.

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Editor’s note: This article is the first in a four-part series on the rise of sovereign wealth funds and what they mean for U.S. investors. Part II will appear next Friday on GIW.

Rolling Snake Eyes

For those of you who have played craps, you know that it can be a pretty easy game to win at, even when you really don’t know what you’re doing. When someone is on a hot streak, everyone at the table can partake in the winnings. A main nemesis in the game is rolling the dreaded “snake eyes” (what’s known as a pair of pips among gamblers). Interestingly, and perhaps not coincidentally for our purposes here, the etymology of the reference traces back to 1929 – the onset of the Great Depression.

Several months ago, sovereign wealth funds (SWFs) from Singapore, Kuwait, Saudi Arabia, Abu Dhabi and Korea stepped up to the table to test their luck. These five government-sponsored funds went high stakes with their chips by collectively pouring nearly $60 billion into Citigroup, UBS and Merrill Lynch. These “experts” (bolstered by their outside advisors) were confidant that the sell-off which had rampaged Wall Street beginning in mid-2007 and continuing into early 2008 had reached its end. They thought they were correctly timing their purchase at the bottom of the downturn. No such luck. There was more carnage to come. Snake eyes all around.

Still smarting from their dramatic losses, many of these funds were invited in June to return to Casino High Finance, this time by Lehman Brothers. But unfortunately for Richard Fuld and his band of con artists, the managers at these funds had learned their lesson and declined the invitation to return to Las Vegas for one more roll of the dice. We will never know if that second roll would have brought more misery or good fortune, but something tells me the odds favored the house.

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