What started as the actions of rogue forex traders operating outside risk management guidelines escalated into one of Australia’s nastiest public boardroom brawls. With the boardroom divided, institutional shareholders demanded an end to the ego-driven dispute that was tarnishing the brand name of the NAB. So how could the board of the country’s largest banking institution fall apart like a house of straw or sticks once the winds started blowing? What are the lessons to emerge from the NAB saga?
The NAB Lessons
What started as the actions of rogue forex traders operating outside risk management guidelines escalated into one of Australia's nastiest public boardroom brawls. With the boardroom divided, institutional shareholders demanded an end to the ego-driven dispute that was tarnishing the brand name of the NAB. So how could the board of the country's largest banking institution fall apart like a house of straw or sticks once the winds started blowing? What are the lessons to emerge from the NAB saga?
Company Director editor John Arbouw put this question to a panel comprising Bill Beerworth (Beerworth & Partners), Ian Ramsay (University of Melbourne and author of the Ramsay Report into auditor independence), Graham Bradley (former CEO of Perpetual Trustees), Peter Morgan (institutional investment firm 452 Capital) and Ralph Evans (CEO, Australian Institute of Company Directors)
Beerworth: If you needed to prove that you can't afford to have a public falling out, it has been proven in this case because the cost to the NAB has been immense and ongoing. In this day and age where everybody can get information, you cannot afford to paper things over.
This would be my No.1 lesson and I am thinking of HomeSide (the costly mortgage lending failure in the US). I thought NAB dealt badly with this at the time. As well, the NAB forex scandal is the only instance I can remember where the CEO was really punished within a week. The scandal broke on the Monday and by Friday everyone was calling for Frank Cicutto's resignation. That struck me as extraordinary. Part of the reason is that journos talk to people like Peter Morgan who have long memories and are concerned that if you get a blow upon a bruise, then that fellow should go. It took a couple more weeks but he was finished at the end of that week. The lesson is that you can't afford to paper things over.
Today, there is really not just a requirement for a genuinely well-balanced board but also one that requires genuine expertise. There was very little bank or financial services expertise on the NAB board and that ultimately proved to be the major undoing.
The final lesson is obviously the critical role of having a chairman who doesn't have a major ego. I had the impression that Graham Kraehe had a very large ego and therefore he and Catherine Walter fell out big time and a big public company cannot afford to have that kind of falling out.
Evans: It appears to me that we are in an era now that not all boards recognise fully. Boards are held far more accountable than they were a decade before and this is probably due to the rise of instos, their analysts and the transparency that has come along as a result of IT.
Every major board these days has several bright and highly driven people looking over shoulders and who have very specific theories on the strategy of the company and if things go badly they will hold the company and the board potentially accountable. I think this was the case here.
Morgan: With the NAB there were a number of issues that worried the marketplace including HomeSide. At the time of HomeSide, we questioned the bank a number of times, including visiting the chairman and we were run around and treated pretty badly. There was no ownership of HomeSide. That then rolled into a number of other issues that were worrying to myself and other players in the market. For instance, we had the raid on AMP that failed. We had the NAB investment position in St George that was talked about being a core position only to have it unwind shortly thereafter.
We had other things articulated to us by the finance director, the managing director that the provision for doubtful debts was now being treated as an allocation of capital. Things were happening behind the scenes and the market lost confidence.
We then had the report by APRA (Australian regulator) which suggested that the culture of the bank was revolving around profit being king, which was dangerous for a banking enterprise.
It also appeared that the main board had not read the APRA report. We had the CEO go and a new chairman appointed. In many ways the situation could have been handled a lot better early on.
Bradley: In my view the issue to come out of the NAB is that it is clearly not in shareholder interests to have wholesale board resignations, leaving only the most junior directors to manage the board reconstruction.
Yet how should directors, who have overseen companies that have suffered major business failure, act and react? Are there circumstances where they should not be free to resign and jump ship until the shareholders are given an independent report on what happened? Are some directors more accountable than others: for instance, audit committee chairmen?
Conventional wisdom is that all directors are equally answerable for all aspects of the company's governance. Audit committees, and other committees, are simply mechanisms for the board to apply focussed attention to certain areas of responsibility, but the whole board remains responsible and accountable.
That means there is no higher responsibility for some directors above others and, if a committee falls down on the job, despite diligence, the whole board must bear the consequences.
Is this still the right theory? Or are the courts and best practice moving on this topic? Are audit committee chairmen (and members) to have higher responsibility to shareholders than other directors? If so, are we paying enough attention to the scope of audit committee charters and responsibility? Should audit committees report directly to shareholders, eg. at AGMs? Are we compensating audit committees commensurately with their larger accountability?
Another issue is what remedies do a board or chairman have when, to their satisfaction, one director is breaching board confidences?
Should there be a mechanism, short of calling an EGM, for the majority to remove a director? Conventional wisdom says no: a director is elected by shareholders and the very inability of the board or management to remove a director is a bulwark against the majority of directors acting against shareholder interest. Is this still good theory and practice? An analogy is the removal of a US president, achievable only by a complicated impeachment process, compared to the comparative ease of removal of a prime minister under the Westminster system. Both work, both are consistent with democracy, but one is easier than the other and neither require a vote of the electors (shareholders).
Ramsay: The first issue that I see is conflict of interest. The whole NAB saga has conflict written all over it. It started with Cathy Walter note that PwC wasn't independent and, at her suggestion, NAB needed probity advisers and also needed Deloittes to come in. Conflicts of interest also ran all over Graham Kraehe's potential chairing of the proposed EGM meeting, everyone thought that would be very inappropriate.
The reason I raise this as a significant issue is that the NAB is a large financial institution in a small domestic market. These conflicts are always going to exist as concentration increases in financial services. As these conflicts become more evident, you have to have robust ways in which to deal with them. The NAB didn't have these.
If it is true that Cathy Walter was the first one to say that PwC wasn't independent because they are doing $12 million worth of business with NAB and a former PwC partner is working to create some of the IT systems, then at the higher levels no one was handling issues of conflict.
I agree with Bill's point about expertise on the board and would add that the current debate about independence has overtaken the issue about expertise. You need to set up appropriate committees to deal with challenges that the board might confront.
The next point is the increasing influence of shareholders generally and to what extent was the board really in touch with the shareholders, both institutional and retail.
As well, there was a lot of press given to proxy advisory firms, two of which were diametrically opposed in the advice they were offering. These firms seem to be growing in number, and possibly in influence, but I would question whether they always do a good job of getting to the heart of the issue.
Company Director: Do you believe that the various NAB committees were too consumed by process and therefore lost their way?
Ramsay: If the details coming out of the PwC and APRA reports are to believed, then some of the committee structures could have and should have worked better. When I talk about committee structure I would also have to include the flow of information from management to those committees which is very important. On both counts there is clearly significant scope for improvements. There is also an issue of who would chair, say, the audit committee. Given all the exposure both here and overseas in ratcheting up expertise, particularly financial expertise on audit committees, does a commercial lawyer, have the necessary financial expertise and is therefore the right person these days to chair a financial audit committee of NAB?
This is an important question.
Bradley: The NAB had a newly-established risk committee of the board. Is this a good model? Should other boards adopt this approach?
Traditionally, audit committees also look at risk and legal compliance. Is a separate committee a good idea or will it serve to confuse accountability of the audit committee?
How should its charter be defined and what independent resources does it need to do its job? This issue raises the merits of the two-tiered board structure prevalent in Europe, with a supervisory board focussed solely on risk, controls, and governance issues and a second board focussed on business strategy - a model advocated by Richard
Walsh in a recent thoughtful article in the Australian Financial Review.
Company Director: Should Australia follow the suggestions laid down in the US Sarbanes-Oxley legislation that directors serving on audit committees must show that they have the necessary financial expertise?
Ramsay: I wouldn't necessarily go down that path. For instance, a former governor of the Reserve Bank of Canada told me he would not qualify under the Sarbanes-Oxley criteria and chair a US company's audit committee. However, there is an appropriate rethinking on the part of listed companies as to the role of audit committees and who serves on them. When I conducted my research into audit practices, a number of auditors told me a big problem was meeting with audit committee members who were out of their depth. It is time to rethink this, including who chairs audit committees.
Company Director: Peter, from an investors point of view is this an important issue?
Morgan: I have always had my doubts whether members of that audit committee understood what was going in terms of terminology and the sophisticated financial instruments that were coming their way.
Now, I can't prove that in any way but I can't believe that as a result of what occurred that there was an absolute understanding of Value at Risk or butterfly spreads or whatever. They are highly technical issues and may not have been well understood. The markets have become very sophisticated and I don't pretend to understand some of the instruments that are being used.
Evans: Richard Leblanc (see story, page 12) made a point at the AICD conference that expertise matters far more than independence. He has a kind of model of a two-tiered matrix that he would like to see on an effectively performing board.
The directors are one dimension and they require the sorts of expertise that will allow them to govern the company and, if this is a business that is involved in sophisticated financial instruments, then someone on the board needs to know the lingo and what it means or you can't function. The other dimension is the psychological behavioural issues of the board and its directors and how this is balanced.
Morgan: This is a very important point. The use of independents has gotten out of hand. The structure of traditional Australian banks has changed tremendously over the past decade and this gets back to whether the structure of boards has kept up.
Company Director: The institutions played a very strong role in dictating what the NAB board should do. Is this another sign that institutions are more prepared to step in when problems happen?
Morgan: It is a sign not only that they will but that they should. However, I am against the lobbying of shareholders to get an end result.
Corporate governance among institutional shareholders has lifted after coming off a low base and there is greater interest being taken. With the NAB, almost every fund in Australia would have a position with the bank in terms of its holdings and this has a bearing on why institutions played their part. I think the institutions will increase their role but it throws into question the issue of lobbying.
Ramsay: Peter, in terms of HomeSide, I remember the institutions being much quieter in the wake of this affair.
Morgan: I think you are right. A lot of institutional investors gave the NAB the benefit of the doubt in regards to HomeSide. But when it happened again, enough was enough. Don't forget if it wasn't for a whistleblower, the forex scandal could have been a lot worse. As well, institutions are only the fund managers. Trustees who are reporting back to their own members are casting a lot of the votes and there is a lot of pressure on them to act in an appropriate manner.
Company Director: What are the lessons in terms of the role of the chairman?
Ramsay: As a chair, you have special responsibilities and you are the public spokesperson on a range of matters that the CEO might not be able to address.
Therefore you have to be careful on going public on certain matters in particular internal disputes. There is no doubt the NAB chairman profoundly misjudged this issue.
Morgan: What continues to amaze me as an institutional shareholder is the lack of contact institutions have with the chairman. Every institution meets the managing director but the hit rate in terms of the chairman would be one in 10.
This is one of the weaknesses in the overall process in that there is not enough interaction. This doesn't mean you have to discuss the issues of the company and risk entering the private briefings situation and contravene continuous disclosure rules. It simply means opening a line of communication.
At the end of the day the chairman and his board are representatives of the shareholders. I don't want selective information but there just has to be more opportunity to meet.
Ramsay: I agree with that but I would also say that a vital role of the chairman is ensuring that the board selection process produces the best directors. If people make comments about the shortcomings of expertise among the directors, it puts in question the role of the chair in getting the best possible directors. This gets back to the issue of expertise and appropriate committees.
Evans: We have to recognise that our biggest companies in this country have become very much bigger and more complicated than they were a generation ago.
I don't think the professionalism of boards and directors have necessarily kept pace. We have had major problems before such as what occurred at BHP a few years ago.
Perhaps this is corporate governance in action and we should see this as the glass half full whereby these problems get fixed.
As it turned out the NAB board couldn't fix all of its own problems so it went to the shareholders and I think that is the right thing to do.
I have heard people say that a board should remove a director who is a nuisance but that isn't necessarily a good thing.
Directors are the representatives of shareholders and if you gave that power to their peers, you might limit the healthy and aggressive debates in the boardroom.
You wouldn't want to have someone thrown out because they weren't going with the flow.
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