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Intervention by Denise Caruso Read Intervention by Denise Caruso, Executive Director of the Hybrid Vigor Silver Award Winner, 2007 Independent Publisher Book Awards; Best Business Books 2007, Strategy+Business Magazine

THE CITIGROUP CASE STUDY:
IS CORPORATE MALFEASANCE AVOIDABLE?

by Mike Neuenschwander ~ November 23, 2008.
Permalink | Filed under: Hybrid Vigor, Social Trust Online.

One of the most baffling characteristics of human nature is the tendency for apparently normal individuals can exhibit both Dr. Jekyll and Mr. Hyde traits depending on social circumstance. We’re somehow shocked to discover that among the predators in online chat rooms and the clients of exotic escort agencies are some of our trusted advisers, friends, and neighbors.

Corporate malfeasance cases put a spin on this issue, because many of the perpetrators accused of malfeasance feel they’ve done nothing wrong, even after conviction.

And in a sense, they’re right.

In a corporate setting, individuals are continually asked to balance self-interest with company interest and (for the few who bother to think about it) with societal interest. Given the complex environment in which large corporations exist, the “right” action is seldom obvious. Frequently, corporate malfeasance is as much the result of “organizational frailty” (a term I just invented to correspond to human frailty) as it is of willful malicious intent. That is, there’s only an illusion of conscious will in most of these cases. In short, they’re problems of collaboration and trust.

The New York Times today reported how the culture at Citigroup led the company to the brink of ruin. According to the article:

To some, the misery at Citigroup is no surprise. Lynn Turner, a former chief accountant with the Securities and Exchange Commission, said the bank’s balkanized culture and pell-mell management made problems inevitable.

“If you’re an entity of this size,” he said, “if you don’t have controls, if you don’t have the right culture and you don’t have people accountable for the risks that they are taking, you’re Citigroup.”

The following excerpt from the article will likely sound familiar to anyone familiar with office politics:

According to a former Citigroup executive, Mr. Prince started putting pressure on Mr. Maheras and others to increase earnings in the bank’s trading operations, particularly in the creation of collateralized debt obligations, or C.D.O.’s — securities that packaged mortgages and other forms of debt into bundles for resale to investors.

Because C.D.O.’s included so many forms of bundled debt, gauging their risk was particularly tricky; some parts of the bundle could be sound, while others were vulnerable to default.

“Chuck Prince going down to the corporate investment bank in late 2002 was the start of that process,” a former Citigroup executive said of the bank’s big C.D.O. push. “Chuck was totally new to the job. He didn’t know a C.D.O. from a grocery list, so he looked for someone for advice and support. That person was Rubin. And Rubin had always been an advocate of being more aggressive in the capital markets arena. He would say, ‘You have to take more risk if you want to earn more.’ ”

It appeared to be a good time for building up Citigroup’s C.D.O. business. As the housing market around the country took flight, the C.D.O. market also grew apace as more and more mortgages were pooled together into newfangled securities.

From 2003 to 2005, Citigroup more than tripled its issuing of C.D.O.’s, to more than $20 billion from $6.28 billion, and Mr. Maheras, Mr. Barker and others on the C.D.O. team helped transform Citigroup into one of the industry’s biggest players. Firms issuing the C.D.O.’s generated fees of 0.4 percent to 2.5 percent of the amount sold — meaning Citigroup made up to $500 million in fees from the business in 2005 alone.

Even as Citigroup’s C.D.O. stake was expanding, its top executives wanted more profits from that business. Yet they were not running a bank that was up to all the challenges it faced, including properly overseeing billions of dollars’ worth of exotic products, according to Citigroup insiders and regulators who later criticized the bank.

When Mr. Prince was put in charge in 2003, he presided over a mess of warring business units and operational holes, particularly in critical areas like risk-management and controls.

“He inherited a gobbledygook of companies that were never integrated, and it was never a priority of the company to invest,” said Meredith A. Whitney, a banking analyst who was one of the company’s early critics. “The businesses didn’t communicate with each other. There were dozens of technology systems and dozens of financial ledgers.”

Problems with trading and banking oversight at Citigroup became so dire that the Federal Reserve took the unusual step of telling the bank it could make no more acquisitions until it put its house in order.

In 2005, stung by regulatory rebukes and unable to follow Mr. Weill’s penchant for expanding Citigroup’s holdings through rapid-fire takeovers, Mr. Prince and his board of directors decided to push even more aggressively into trading and other business that would allow Citigroup to continue expanding the bank internally.

The strategy paid off for a while of course:

After that, the bank moved even more aggressively into C.D.O.’s. It added to its trading operations and snagged crucial people from competitors. Bonuses doubled and tripled for C.D.O. traders. Mr. Barker drew pay totaling $15 million to $20 million a year, according to former colleagues, and Mr. Maheras became one of Citigroup’s most highly compensated employees, earning as much as $30 million at the peak — far more than top executives like Mr. Bushnell in the risk-management department.

And of course there was a good amount of self-delusion going around:

In fact, when examiners from the Securities and Exchange Commission began scrutinizing Citigroup’s subprime mortgage holdings after Bear Stearns’s problems surfaced, the bank told them that the probability of those mortgages defaulting was so tiny that they excluded them from their risk analysis, according to a person briefed on the discussion who would speak only without being named.

The Citigroup experience isn’t an outlier; it’s a morality play about the human condition. The experience certainly begs the question: given our innate ability to adjust to the needs of a social structure, our inability to judge ourselves objectively, and our limited field of perception, is corporate malfeasance unavoidable?

1 Response to THE CITIGROUP CASE STUDY:
IS CORPORATE MALFEASANCE AVOIDABLE?

  1. Denise Caruso

    Absolutely it’s avoidable. Malfeasance lives in secrecy, in the dark. It cannot live in the light of disclosure. Transparency — far more transparency than we’ve got now in corporate infrastructure — would significantly decrease the ability for malfeasance to take root.

    Inviting others to view our actions (with ensuring integrity as the motive) solves all the very real issues you raise: it challenges the existing social structure, provides outsider perspectives to judge our actions, and opens our field of perception.

    This kind of transparency is (as you know) at the core of the risk methods for assessing innovative technologies that I love so dearly: bring together stakeholders and interested parties and ask the question at hand. I’m sure it would work just as well if the problem on the table was “Is anything we are doing right now putting us on the path to becoming greedy, malfeasant boneheads?”

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